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FORM 10-K
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

MOOG Inc.
(Exact Name of Registrant as Specified in its Charter)

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:         None

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes    √               No      

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.     

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).   Yes     No    √ 

The aggregate market value of the Common Stock outstanding and held by non-affiliates (as defined in Rule 405 under the Securities Act of 1933) of the registrant, based upon the closing sale price of the Common Stock on the New York Stock Exchange on March 29, 2002, the last business day of the registrant's most recently completed second quarter, was approximately $389 million.

The number of shares of Common Stock outstanding as of the close of business on December 4, 2002 was:
Class A 13,060,694; Class B 2,109,392.

The documents listed below have been incorporated by reference into this Annual Report on Form 10-K:
(1) Portions of the Annual Report to Shareholders for the fiscal year ended September 28, 2002 (the "2002 Annual Report") are incorporated by reference into Part I of this Form 10-K.

(2) Portions of the January 2003 Proxy Statement to Shareholders (the "2003 Proxy") are incorporated by reference into Part III of this Form 10-K.

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Moog Inc.

FORM 10-K INDEX

Cautionary Statement

Information included herein or incorporated by reference that does not consist of historical facts, including statements accompanied by or containing words such as "may," "will," "should," "believes," "expects," "expected," "intends," "plans," "projects," "estimates," "predicts," "potential," "outlook," "forecast," "anticipates," "presume" and "assume," are forward-looking statements. Such forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are not guarantees of future performance and are subject to several factors, risks and uncertainties, the impact or occurrence of which could cause actual results to differ materially from the expected results described in the forward-looking statements. These important factors, risks and uncertainties include (i) fluctuations in general business cycles and demand for capital goods, (ii) the Company's dependence on government contracts that may not be fully funded or may be terminated, (iii) the Company's dependence on certain major customers, such as The Boeing Company, for a significant percentage of its sales, (iv) the Company's dependence on the commercial aircraft industry which is highly cyclical and sensitive to fuel price increases, labor disputes, and economic conditions, (v) the possibility that advances in technology could reduce the demand for certain of the Company's products, specifically hydraulic-based motion controls, (vi) the use of electronic auctions by customers to award business, (vii) intense competition on the Company's business which may require the Company to compete by lowering prices or by offering more favorable terms of sale, (viii) the Company's significant indebtedness which could limit its operational and financial flexibility, (ix) higher pension costs and increased cash funding requirements which could occur in future years if future actual plan results differ from assumptions used for the Company's Defined Benefit Pension Plans, including returns on plan assets and interest rates, (x) a write-off of all or part of the Company's goodwill which could adversely affect the Company's operating results and net worth and cause it to violate covenants in its bank agreements, (xi) the potential for substantial fines and penalties or suspension or debarment from future contracts in the event the Company does not comply with regulations relating to defense industry contracting, (xii) the potential for cost overruns on development jobs and fixed-price contracts and the risk that actual results may differ from estimates used in contract accounting, (xiii) the Company's ability to successfully identify and consummate acquisitions and integrate the acquired businesses, (xiv) the possibility of a catastrophic loss of one or more of the Company's manufacturing facilities, (xv) the impact of product liability claims related to the Company's products used in applications where failure can result in significant property damage, injury or death, (xvi) foreign currency fluctuations in those countries in which the Company does business and other risks associated with international operations, and (xvii) the cost of compliance with environmental laws. The factors identified above are not exhaustive. New factors, risks and uncertainties may emerge from time to time that may affect the forward-looking statements made herein. Given these factors, risks and uncertainties, investors should not place undue reliance on forward-looking statements as predictive of future results. The Company disclaims any obligation to update the forward-looking statements made in this report.

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Part I

The Registrant, Moog Inc., a New York corporation formed in 1951, is referred to in this Annual Report on Form 10-K as "Moog," "the Company" or in the nominative "we" or the possessive "our."

ITEM 1. Business.

Certain information required herein is incorporated by reference to the 2002 Annual Report.

Description of the Company's Business. See pages 2 through 19 of the 2002 Annual Report.

Distribution. Moog's sales and marketing organization consists of individuals possessing highly specialized technical expertise. This expertise is required in order to effectively evaluate a customer's precision control requirements and to facilitate communication between the customer and Moog's engineering staff. Moog's sales staff is the primary contact with customers. Manufacturers' representatives are used to cover certain domestic aerospace markets. Distributors are used selectively to cover certain industrial markets.

Industry and Competitive Conditions. The Company is a leading worldwide designer and manufacturer of a broad range of high performance precision motion and fluid controls and control systems for a broad range of applications in the aircraft, space and industrial markets. The Company experiences considerable competition in each of these three markets.

Many of our competitors have greater financial and other resources. In Aircraft Controls, the Company's principal competitors include Parker Hannifin Corporation, Curtiss-Wright Corporation, Liebherr-Holding GmbH, Lucas Aerospace Power Equipment Corporation, a subsidiary of Goodrich Aeronautical Systems, formerly TRW Flight Controls, and Teijin Seiki Co., Ltd. In Space Controls, the Company's principal competitors include Valve Tech Inc., Vacco Industries, Inc., Honeywell International Inc., Starsys and Textron. In Industrial Controls, competitors include Bosch Rexroth AG, Siemens, Pacific Scientific Company and Yaskawa Electric Corporation.

Competition in each market served is based upon design capability, product performance and life, service, price and delivery time. The Company believes it competes effectively on all of these bases.

Backlog. Substantially all backlog will be realized as sales in the next twelve months. Also see the discussion in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, beginning on page 26 of this report.

Raw Materials. Materials, supplies and components are purchased from numerous suppliers. The Company believes the loss of any one supplier, although potentially disruptive in the short term, would not materially affect the Company's operations in the long term.

Working Capital. See the discussion on operating cycle in Note 1 of Item 8, Financial Statements and Supplementary Data, on page 38 of this report.

Seasonality. Moog's business is generally not seasonal.

Patents. Moog has numerous patents and has filed applications for others. While the protection afforded by these is of value, the Company does not consider the successful conduct of any material part of its business to be dependent upon such protection. The Company's patents and patent applications, including U.S. and international patents, relate to electrohydraulic, electropneumatic and electromechanical actuation mechanisms and control valves, electronic control component systems and interface devices. The Company has trademark and trade name protection in major markets throughout the world.

Research Activities. Research and product development activity has been and continues to be significant to the Company. See Item 6, Selected Financial Data, on page 25 of this report.

Employees. On September 28, 2002, the Company employed 4,817 full-time employees, compared to 4,901 full-time employees on September 29, 2001.

Segment Financial Information. See the discussion in Note 12 of Item 8, Financial Statements and Supplementary Data, on pages 47 and 48 of this report.

Customers. The information required herein is incorporated by reference to pages 2 through 20 of the 2002 Annual Report. Also see pages 26 and 47 of this report. The Company's customers fall into three groups, Original Equipment Manufacturer (OEM) customers of its aircraft and space businesses, OEM customers of its industrial business, and aftermarket customers in all three businesses. Aircraft and space OEM customers collectively represented 45% of fiscal 2002 sales. The majority of these sales are to a small number of large companies. Due to the long-term nature of many of the programs, many of the Company's relationships with aircraft and space OEM customers are based on long-term agreements. The Company's sales of industrial controls are to a diversity of customers around the world and are normally based on lead times of 90 days or less. The Company also provides spare and replacement parts and repair and overhaul services, or aftermarket, for most of its product applications. The Company's major aftermarket customers include the U.S. government and the commercial airlines.

The Boeing Company represented approximately 14% of consolidated sales in 2002, including sales to the Boeing Commercial Airplane Group which represented 8% of fiscal 2002 sales. Sales to the U.S. Government and its prime- or sub-contractors, including military sales to Boeing, were approximately 33% of sales. Sales to these customers are made primarily from Aircraft Controls and Space Controls.

International Operations. Operations outside the United States are conducted through wholly-owned foreign companies. The Company's international operations are located predominantly in Europe and the Asian-Pacific region. See pages 48 and 53 of this report. The Company's international operations are subject to the usual risks inherent in international trade, including currency fluctuations, local governmental restrictions on foreign investment and repatriation of profits, exchange controls, regulation of the import and distribution of foreign goods, as well as changing economic and social conditions in countries in which such operations are conducted.

Environmental Matters. See the discussion in Note 13 of Item 8, Financial Statements and Supplementary Data, on page 48 of this report.

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ITEM 2. Properties.

The Company occupies approximately 2,448,000 square feet of space in the United States and countries throughout the world, distributed by segment as follows:

Aircraft Controls has principal manufacturing facilities located in New York, California, Utah, England and the Philippines. Space Controls has primary manufacturing facilities located in New York and California. Industrial Controls has principal manufacturing facilities located in New York, Germany, Italy, Japan, Ireland and Luxembourg. The Company's headquarters are located in East Aurora, New York.

The Company believes that its properties have been adequately maintained and are generally in good condition. Operating leases expire at various times from December 2003 through November 2013. Upon the expiration of its current leases, the Company believes that it will be able to either secure renewal terms or enter into leases for alternative locations at market terms.

ITEM 3. Legal Proceedings.

From time to time, the Company is named as a defendant in legal actions. The Company is not a party to any pending legal proceedings which management believes will result in a material adverse effect on the Company's financial condition.

ITEM 4. Submission of Matters to a Vote of Security Holders.

None.

Part II

ITEM 5. Market for the Registrant's Common Equity and Related Stockholder Matters.

Moog's two classes of common shares, Class A Common Stock and Class B Common Stock, are traded on the New York Stock Exchange (NYSE) under the ticker symbols MOG.A and MOG.B. The following chart sets forth, for the periods indicated, the high and low sales prices of the Class A Common Stock and Class B Common Stock on the NYSE beginning August 27, 2001 and on the American Stock Exchange (AMEX) prior to August 27, 2001. Prior to August 27, 2001, Moog's two classes of common shares were traded on the AMEX under the same ticker symbols. Prices prior to the September 21, 2001 three-for-two split of the Company's Class A and Class B Common stock effected in the form of a stock distribution have been restated.

The number of shareholders of record of Class A Common Stock and Class B Common Stock was 1,297 and 615, respectively, as of December 4, 2002.

Dividend restrictions are detailed in Note 7 of Item 8, Financial Statements and Supplementary Data, on page 41 of this report. The Company does not pay dividends on its Class A Common Stock or Class B Common Stock.

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ITEM 6. Selected Financial Data.

For a more detailed discussion of 2000 through 2002, refer to Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, on pages 26 through 33 of this report and Item 8, Financial Statements and Supplementary Data, on pages 34 through 50 of this report.

(dollars in thousands except per share data)

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ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

All references to years in this Management's Discussion and Analysis of Financial Condition and Results of Operations are to fiscal years.

Overview

Moog is a leading worldwide designer and manufacturer of a broad range of high performance precision motion and fluid controls and control systems for a broad range of applications in aerospace and industrial markets. In 2002, approximately 42% of the Company's sales were related to military defense or government funded programs. The Company has three operating segments.

Aircraft Controls designs and manufactures technologically advanced flight and engine controls for manufacturers of military and commercial aircraft. Moog supplies flight controls for major, in-production military aircraft, including the U.S. Navy's F/A-18E/F Super Hornet fighter aircraft, the V-22 Osprey tiltrotor aircraft and the F-15 Eagle. The Company is the contract lead for developing flight controls for the System Development and Demonstration phase of the F-35 Joint Strike Fighter program, teaming with Parker Hannifin, Hamilton Sundstrand and Curtiss-Wright. The F-35 is the next generation fighter aircraft to be used by all three branches of the U.S. military and several foreign governments. The Company is a supplier to both commercial large body aircraft manufacturers, The Boeing Company and EADS, and business aircraft manufacturers including Raytheon Company and Bombardier Inc. Aftermarket sales, including repairs and spare parts, represented 39% of Aircraft Controls revenues in 2002.

Space Controls designs and manufactures controls and systems that control the flight, positioning or thrust of tactical and strategic missiles, launch vehicles, satellites and NASA's Space Shuttle. Customers include Alliant Techsystems Inc., Lockheed Martin, Astrium Ltd., Raytheon and Boeing. Moog participates on tactical missile programs such as AGM-142 Popeye, VT-1, Hellfire and TOW, missile defense programs such as the Ground-Based Midcourse Defense program, or GMD, the Space Station Crew Return Vehicle and the Atlas and Delta Evolved Expendable Launch Vehicles.

Industrial Controls designs and manufactures hydraulic and electric controls used in a variety of industrial applications. Product applications include plastic injection and blow molding machines, steam and gas turbines, steel rolling mills, fatigue testing machines, motion simulators and gun and turret positioning and ammunition-loading systems on combat vehicles.

On November 20, 2001, the Company completed the sale of 1,980,000 Class A common shares at $21.00 per share. The net proceeds to the Company of $39 million were used to repay outstanding debt. On September 21, 2001, the Company distributed Class A and B common stock in a three-for-two stock split effected in the form of a 50% stock distribution. Share and per share amounts included herein have been restated where applicable to show the effects of the stock split.

2002 Acquisitions

On March 29, 2002, the Company acquired 81% of the stock of Tokyo Precision Instruments Co. Ltd. (TSS) from Mitsubishi Electric Corporation and other shareholders for $0.6 million in cash. TSS's balance sheet, which is consolidated in the Company's financial statements, included $4 million of net funded debt and $2 million of cash as of March 29, 2002. As of September 28, 2002, the Company had acquired 98.8% of TSS for $0.8 million. TSS manufactures high-performance servovalves, hydraulic systems and pneumatic components for a variety of industrial applications.

On October 25, 2001, the Company purchased the net assets of the satellite and space vehicle business of the Electro Systems Division of Tecstar, Inc. for $8 million in cash. The acquired business of Tecstar's Electro Systems Division manufactures electromechanical equipment for spacecraft.

Critical Accounting Policies - Estimates or Judgments

The Company's financial statements and accompanying notes are prepared in accordance with generally accepted accounting principles in the United States. The preparation of these consolidated financial statements requires management to make estimates, assumptions and judgments that affect the amounts reported. These estimates, assumptions and judgments are affected by management's application of accounting policies, which are discussed in Note 1 to the Consolidated Financial Statements. The Company's critical accounting policies relate to revenue recognition on long-term contracts, contract loss reserves, reserves for inventory valuation, review for impairment of goodwill, pension assumptions and deferred tax asset valuation allowances. These critical accounting policies were reviewed with the Audit Committee of the Company's Board of Directors.

Revenue Recognition on Long-Term Contracts. In 2002, 43% of the Company's sales were accounted for using the percentage of completion (cost-to-cost) method of accounting for long-term contracts which recognizes sales and costs as work is performed in advance of the delivery of the product. The percentage of completion (cost-to-cost) method of accounting is used primarily on the Company's aircraft and space contracts, which typically have longer performance cycles, resulting in the matching of sales with costs as they are incurred throughout the duration of the contract. The remaining 2002 sales were recognized when the risks and rewards of ownership and title to the product transferred to the customer, principally as units were shipped.

Percentage of completion (cost-to-cost) accounting for long-term contracts requires a disciplined cost estimating system in which all functions of the business are integrally involved. The Company believes it has adequate systems and procedures that result in complete and accurate cost estimates by contract. These cost estimates rely on engineering and manufacturing assessments of progress achieved against technical or performance milestones, and are validated using applicable product or project cost history.

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Contract prices, or contract values, are generally based on the terms and conditions specified in the contract or in the related customer purchase orders. However, the effort required under a contract can change during the performance period. These changes are typically in the form of a directed scope change from the customer, or a claim by the Company for an adjustment to the contract value based upon requirements that are different from the contract's baseline requirements. The Company includes an estimate of scope changes or claims in the contract value for purposes of revenue recognition only when that amount can be reliably estimated and when realization is considered probable. At September 28, 2002, approximately $5.7 million of unnegotiated scope changes or claims were included in contract values used in the determination of 2002 sales and operating profit.

The Company reviews contract cost estimates and contract values, including unnegotiated claims and scope changes, on a quarterly basis. As a result of these reviews, sales and costs of sales are appropriately recorded in the statement of earnings to reflect the most current assessment of each contract's percentage of completion.

Contract Loss Reserves. For contracts in which the estimated costs at completion, exclusive of allocated general and administrative period costs, exceed the estimated contract value, a loss reserve for the entire remaining loss is recorded when the loss becomes known. Loss reserves are more common on firm fixed-price contracts that involve, to varying degrees, the design and development of new and unique controls or control systems to meet customers' specifications. The determination of contract loss reserves is made on a specific contract basis and, therefore, no general reserves are maintained.

Once established, the amount of the loss reserve is reviewed at least quarterly and adjusted, if necessary, based on progress made and on updated cost estimates including a current assessment of any remaining risks.

Provisions for losses on contracts are reflected in the statement of earnings as additional cost of sales. As costs are incurred, the previously established contract loss reserve included in current liabilities is reduced. As of September 28, 2002, contract loss reserves were $13.9 million.

Reserves for Inventory Valuation. As of September 28, 2002, inventories represent approximately 18% of total assets and 35% of current assets. Inventories are stated at lower-of-cost-or-market with cost determined primarily on the first-in, first-out method of valuation and exclude amounts allocated to long-term contracts in progress.

The Company records valuation reserves to provide for slow-moving or obsolete inventory or to reduce inventory to net realizable value.

For slow-moving or obsolete inventory, the Company uses both a formula-based method that increases the valuation reserve as the inventory ages and, supplementally, a specific identification method. Determining the appropriate reserve for inventory valuation requires significant knowledge of the business. Management considers overall inventory levels in relation to firm customer backlog as well as forecasted demand including consideration of aftermarket sales. Inventory obsolescence reserves also consider issues such as low demand or technological obsolescence. The Company's inventory valuation reserve represents a reduction in inventory cost which creates a new cost basis of accounting. The reserve amount is maintained in a general ledger account separate from the gross inventory cost. Once a reserve is established for an inventory item, it is removed upon the subsequent use or disposition of the item. As of September 28, 2002, the reserve for inventory valuation was $27.5 million, or 14% of gross inventories.

Reviews for Impairment of Goodwill. The Company adopted the provisions of Statement of Financial Accounting Standards Board (SFAS) No. 142, "Goodwill and Other Intangible Assets," on October 1, 2001. Under SFAS No. 142, goodwill is no longer amortized, but is reviewed for impairment at least annually at the reporting unit level. As of September 28, 2002, the Company had $192.9 million of goodwill.

In testing for impairment of goodwill, companies are required to allocate goodwill among reporting units, estimate fair values of those reporting units and determine their carrying values. The Company's reporting units are the operating segments used for segment reporting: Aircraft Controls, Space Controls and Industrial Controls. This determination was made based on the similarities of the components of these groups as well as the components not qualifying as businesses themselves.

The process of evaluating the Company's goodwill for potential impairment is subjective and requires significant estimates. These estimates include judgments about future cash flows of the reporting units and allocations of commonly shared assets to the reporting units, as well as the estimates of the Company's cost of capital that was used to discount projected future cash flows.

Based on the discounted present values of the projected cash flows, management concluded that there is no impairment of the Company's goodwill.

Pension Assumptions. The Company maintains defined benefit plans covering substantially all employees in six countries. The U.S. plans represent 83% of the consolidated projected benefit obligation as of September 28, 2002. The accounting for these plans is based in part on certain assumptions that may be highly uncertain and may have a material impact on the financial statements if different reasonable assumptions had been used.

The assumption for return on assets reflects the average rate of earnings expected on funds invested or to be invested to provide for the benefits included in the projected benefit obligation. The assumed return on assets of 9.5% used in 2002 for the U.S. plans was determined with reference to the fund's investment mix as of September 29, 2001 of 75% equities and 25% fixed income securities, along with forecasted rates of return on these types of securities. Had the Company selected a return on assets that was 100 basis points lower, pension expense for U.S. plans for 2002 would have been $2 million higher than the amount recorded. The return on assets that will be used in 2003 is 8.5% for U.S. plans.

In addition to the return on assets assumption, assumptions for the rate of compensation increase and discount rate were made. The rate of compensation increase used in determining the 2002 pension cost was 3.7% for the U.S. plans and was determined using

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a long-term projection for inflation in addition to real wage increase assumptions. The discount rate used in determining the 2002 pension cost was 7.0% for U.S. plans. Consistent with prior years, the Company used the AA corporate bond rate as the discount rate for U.S. plans. At September 28, 2002, the discount rate used to value the projected benefit obligation was 6.9%.

Deferred Tax Asset Valuation Allowances. As of September 28, 2002, the Company had total gross deferred tax assets of $61.4 million. These assets relate principally to domestic liabilities or asset valuation reserves including pension and vacation accruals, inventory obsolescence, bad debt reserves and contract loss reserves. The Company believes that based on recent historical earnings performance and current projections, a valuation allowance is not required against the domestic portion of these deferred tax assets, which totaled $49.7 million as of September 28, 2002.

Deferred tax assets recorded as of September 28, 2002 by the Company's foreign subsidiaries totaled $11.7 million, of which $5.5 million relates to net operating losses. The Company has a $2.4 million valuation allowance recorded against this asset as of September 28, 2002 representing 44% of the gross asset related to net operating losses. Management believes this reserve is adequate after considering recent operating performance, future financial projections, tax planning strategies and the allowable tax carryforward period.

MOOG INC.
Results of Operations

Notes: Certain amounts may not add to the total due to rounding.

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References to cost of sales as a percentage of sales, net earnings, diluted EPS and operating margins in the following discussion of results of operations for 2002 compared with 2001 and 2001 compared with 2000 reflect the exclusion of goodwill amortization for all periods. Goodwill amortization expense was $7 million and $6 million in 2001 and 2000, respectively. Goodwill amortization expense, net of taxes, was $5 million and $4 million in 2001 and 2000, respectively.

2002 Compared with 2001

Consolidated. Net sales for 2002 increased 2% to $719 million from $704 million in 2001. Sales increased by $19 million in Aircraft Controls and $4 million in Space Controls, while sales decreased by $8 million in Industrial Controls. Net sales for 2002 included incremental sales of $14 million from industrial and space-related acquisitions.

Cost of sales as a percentage of net sales decreased to 67.9% in 2002 from 69.1% in 2001. The decrease in cost of sales as a percentage of net sales is primarily due to a favorable change in product mix towards more profitable military aircraft sales, in particular aftermarket sales. In 2002, sales of controls for military aircraft represented 28% of net sales compared to 22% of net sales in 2001. In addition, operating losses narrowed on business jets, in part due to a favorable $2 million adjustment in the third quarter of 2002 related to progress made on certain scope change negotiations. These improvements were partially offset by weak margins for industrial products due primarily to lower sales.

Estimated costs to complete are reviewed quarterly for contracts accounted for under the percentage of completion (cost-to-cost) method of accounting. For those contracts with anticipated losses at completion, a contract loss reserve is recorded when the loss becomes known. Additions to contract loss reserves are reflected in the statement of earnings in cost of sales. Additions were $11 million in 2002, mostly related to unforeseen expanded work requirements on certain firm fixed price commercial business jet development contracts. The Company also recorded $1 million of contract loss reserves related to acquisitions as part of purchase accounting. During 2002, $13 million of contract loss reserves, primarily related to business jet development contracts, were utilized as costs were incurred and were reflected as reductions to the previously established contract loss reserve included in current liabilities. Contract loss reserves were also reduced by $2 million related to progress made on certain scope change negotiations for business jet development contracts. The net decrease in contract loss reserves was $3 million in 2002, compared to a net decrease of $4 million in 2001.

Reserves for inventory valuation are recorded for obsolete or slow-moving inventory as well as for reductions of inventory to net realizable value. The net increase in reserves for inventory valuation was $7 million in 2002, compared to a net increase of $2 million in 2001. Additions to the reserve in 2002 were $2 million higher as compared to 2001. The increase is primarily within the Aircraft Controls segment, and to a lesser extent, the Industrial Controls segment where product specifications or projected future demand have changed during the year resulting in inventory levels that, in management's estimation, are in excess of amounts needed to fulfill existing and future sales requirements. Reductions to the reserve resulting from inventory being disposed of were $2 million less in 2002 as compared to 2001, primarily in the Space Controls segment. Most of this inventory had been previously reserved and the reserve balance was relieved when the inventory was disposed.

Research and development expenses increased to $33 million in 2002 from $26 million in 2001. The higher levels of research and development related primarily to a variety of Aircraft Controls initiatives, including a new flap actuation system for the business jet market, a new pump and motor design for military aircraft applications, controls for unmanned combat aircraft and active vibration controls for helicopters.

As a percentage of net sales, selling, general and administrative expenses increased to 16.3% in 2002 from 15.7% in 2001. The increase is primarily attributable to higher personnel-related costs, including wage and salary increases and costs related to a stock-based deferred compensation plan for certain officers and directors, and higher professional fees.

Interest expense decreased to $26 million in 2002 from $32 million in 2001. The decrease in interest expense is due to lower interest rates and reduced debt levels, each contributing approximately equally to the decrease. The reduced debt levels are primarily related to $39 million of net proceeds from the November 2001 equity offering in addition to $30 million of reduced net debt levels related to cash flow from operations.

Other expense was $1 million in 2002 compared to zero in 2001. The increase is primarily due to higher foreign currency exchange impacts in 2002.

The Company's effective tax rate was 29.0% in 2002 compared to 33.5% in 2001. The decrease in the effective tax rate relates to additional export tax benefits that the Company claimed in 2002 on amended 1997, 1998 and 2000 U.S. tax returns and a reorganization of the Company's European operations. This decrease was partially offset by a first quarter charge related to decreasing a deferred tax asset in Europe for a change in a statutory tax rate enacted in 2002. During the fourth quarter, additional tax benefits related to the distribution of foreign earnings were offset by a valuation allowance adjustment related to deferred tax assets associated with net operating losses.

In 2002, net earnings increased 16% to $38 million from $32 million in 2001. Diluted EPS increased 2% to $2.50 in 2002 from $2.45 in 2001.

Aircraft Controls. Net sales in Aircraft Controls increased 6% to $359 million in 2002 from $340 million in 2001. The increase is primarily due to a $20 million increase in sales on fighter aircraft programs, an $18 million increase in military aftermarket sales, related primarily to the F-18 fighter aircraft and the Black Hawk helicopter, and a $4 million increase in sales to OEMs for the Black Hawk and Sea Hawk helicopter programs. The $20 million increase in sales on fighter aircraft programs is primarily comprised of $10 million on the F-35 Joint Strike Fighter, $5 million on the F-15 and $3 million on the F/A-18E/F programs. These increases were partially offset by decreases of $12 million in Boeing OEM sales resulting from lower build rates, $7 million, or 12%, in commercial aftermarket sales related to the reduced number of commercial airplane flights, $2 million in flight controls for Airbus and $2 million related to business jets.

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Operating margins for Aircraft Controls increased to 18.2% in 2002 from 15.6% in 2001. The increase is primarily a result of the higher levels of military aftermarket sales, narrowed operating losses on business jets, including a favorable $2 million adjustment in the third quarter of 2002 related to progress on certain scope change negotiations, and better margins on certain fighter aircraft as production rates increase.

Twelve-month backlog for Aircraft Controls was $239 million at September 28, 2002 compared to $223 million at September 29, 2001. The increase is due to an increase on the F-35 Joint Strike Fighter, partially offset by a decrease for commercial aircraft.

Space Controls. Net sales in Space Controls increased 4% to $107 million in 2002 from $103 million in 2001. An $8 million increase during the first nine months of 2002 was partially offset by a decrease of $4 million in the fourth quarter of 2002 resulting from lower sales of controls for tactical missiles and, to a lesser extent, satellites. The increase in sales for the year is primarily due to increases of $5 million for satellite controls, all related to acquisitions, $3 million on the Space Shuttle refurbishment effort and $3 million on the Hellfire tactical missile program. These increases were partially offset by a $7 million decrease in sales of controls for launch vehicles related to the wind down on the Titan IV program and lower development activity on Evolved Expendable Launch Vehicle programs.

Operating margins for Space Controls decreased to 11.5% in 2002 from 12.9% in 2001. The decrease in margins is primarily related to poor operating performance on contracts associated with the PerkinElmer acquisition in 2001 and lower sales in the fourth quarter of 2002 that resulted in fourth quarter operating margins of 5.6%. These decreases were partially offset by increases due to higher volume and better cost experience on the Space Shuttle refurbishment effort and favorable cost performance on the Crew Return Vehicle, which is nearing completion, and tactical missile programs such as Hellfire, TOW and AGM-142 Popeye.

Twelve-month backlog for Space Controls was $59 million at September 28, 2002 compared to $72 million at September 29, 2001. The decrease primarily relates to programs that are near completion such as the Crew Return Vehicle and reduced orders for satellites and tactical missiles such as the AGM-142 Popeye, which was completed, and the Hellfire missile program that has entered a production break.

Industrial Controls. Net sales in Industrial Controls decreased 3% to $253 million in 2002 from $261 million in 2001. The decrease in sales associated with the global industrial economic slowdown included a $9 million decrease for controls for motion simulators, a $6 million decrease for controls for plastic injection molding machinery, a $5 million decrease for electric drives and a $5 million decrease for turbine controls. These decreases were partially offset by an $11 million increase in sales for combat controls and $9 million of incremental sales from acquisitions.

Operating margins for Industrial Controls decreased to 5.5% in 2002 from 9.1% in 2001. The decrease in margins resulted from low volume in industrial markets and an unfavorable product mix weighted more towards lower margin standard products.

Twelve-month backlog for Industrial Controls was $67 million at September 28, 2002 compared to $69 million at September 29, 2001. Excluding the impact of the acquisition of TSS and foreign currency exchange, backlog decreased by $5 million primarily due to generally soft industrial markets.

2001 Compared with 2000

Consolidated. Net sales for 2001 increased 9% to $704 million from $644 million in 2000. Sales in Industrial Controls increased by $41 million and sales in Aircraft Controls increased by $28 million, while sales in Space Controls decreased by $9 million. Excluding the impact of a stronger U.S. dollar in 2001 compared to foreign currencies, primarily the Euro, British Pound, and the Yen, sales would have increased by an additional $16 million over 2000. During 2001, the Company acquired the space valve business of PerkinElmer, the industrial radial piston pump business of Bosch, Whitton Technology, which designs and manufactures pumps and specialty products for producers of industrial power generating equipment, and Vickers Electrics, which manufactures high-performance industrial electric drives. These acquisitions generated $38 million of sales in 2001.

Cost of sales as a percentage of sales was 69.1% in 2001 compared with 68.7% in 2000. The increase is primarily due to lower margins in Industrial Controls.

In 2001, $7 million of contract loss reserves were recorded, compared to $8 million in 2000. Inventory valuation provisions were $6 million in both 2001 and 2000.

Research and development expense increased by $4 million in 2001 to $26 million, or 3.8% of sales. The increase is attributable to a variety of aircraft initiatives.

Interest expense decreased $1 million to $32 million in 2001 due to a decline in interest rates, partially offset by the impact of the acquisitions.

The Company's effective tax rate for 2001 was 33.5% compared to 34.2% in 2000. The decrease resulted from higher U.S. tax incentives on export sales in 2001.

In 2001, net earnings increased 10% to $32 million compared to $30 million in 2000. Diluted EPS increased 11% to $2.45 in 2001 from $2.21 in 2000.

Aircraft Controls. Net sales in Aircraft Controls increased 9% to $340 million in 2001 compared to $312 million in 2000. Boeing commercial sales increased $12 million due to higher production rates in 2001. Sales of controls increased $12 million for fighter aircraft, primarily the F/A-18E/F for which production levels continued to increase. Sales also increased $3 million for engine controls, $3 million for aftermarket sales, and $1 million for controls on business aircraft. These increases were partially offset by a $3 million decrease in sales on the B-2 bomber program which has been completed.

Operating margins for Aircraft Controls were 15.6% in 2001 compared to 15.1% in 2000. The improvement in margins primarily resulted from favorable product mix and cost performance on production programs. Additions to contract loss reserves were

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$6 million in both 2001 and 2000, primarily related to business jet development contracts.

Twelve-month backlog for Aircraft Controls was $223 million at September 29, 2001 compared to $215 million at September 30, 2000. The increase was due to increases in backlog for military programs including the Black Hawk and Sea Hawk helicopters and F/A-18E/F that outweighs decreases in backlog for commercial aircraft.

Space Controls. Net sales in Space Controls decreased 8% to $103 million in 2001 from $112 million in 2000. A $23 million decrease in sales for launch vehicles, primarily the Titan IV program which was completed in 2001, was partially offset by an increase of $13 million for satellite controls.

Operating margins for Space Controls increased to 12.9% in 2001 from 11.6% in 2000. The improvement in margins is primarily due to cost improvement on newer programs, including the Crew Return Vehicle and various tactical missile programs, as well as increased volume for satellite controls.

Twelve-month backlog for Space Controls increased to $72 million at September 29, 2001 from $65 million at September 30, 2000 primarily related to refurbishments on the Space Shuttle.

Industrial Controls. Net sales in Industrial Controls increased 19% to $261 million in 2001 from $220 million in 2000. Excluding the impact of a strong U.S. dollar relative to foreign currencies, primarily the Euro and the Yen, sales would have increased an additional $13 million. The increase in net sales is primarily related to the acquisitions of the radial piston pump product line, Whitton and Vickers Electrics that generated $37 million of incremental sales in 2001. Excluding the effects of the acquisitions, sales increased $5 million for turbine controls, $2 million for motion simulator controls, $2 million within heavy industry and $6 million for various other industrial applications, while sales to the plastics market decreased $11 million due to softness in the injection molding machinery market, particularly in the Asian-Pacific region.

Operating margins for Industrial Controls decreased to 9.1% in 2001 from 12.0% in 2000. The decline in the margins is primarily attributable to lower volume in the plastics markets and, to a lesser extent, pricing pressures in the turbines business.

Twelve-month backlog for Industrial Controls increased to $69 million at September 29, 2001 from $65 million at September 30, 2000 primarily due to the acquisitions.

Financial Condition and Liquidity

The Company's Credit Facility consists of a term loan payable quarterly through 2005, which had a balance of $45 million at September 28, 2002, and a $265 million revolver of which $133 million was outstanding at September 28, 2002.

The Credit Facility expires in December 2005. Interest on the Credit Facility continues at LIBOR plus a spread that was 175 basis points on September 28, 2002. The Credit Facility is secured by substantially all of the Company's U.S. assets. The Credit Facility contains various covenants that adjust over the term of the facility. As of September 28, 2002, the covenant for minimum Consolidated Net Worth, defined as the sum of capital stock and additional paid-in capital plus retained earnings (or minus accumulated deficits), was $210 million; the covenent for the minimum Interest Coverage Ratio, defined as the ratio of adjusted EBITDA to total interest expense was 2.8; the covenant for the minimum Fixed Charge Coverage Ratio, defined as the ratio of (i) adjusted EBITDA minus capital expenditures to (ii) the sum of interest expense, provision for taxes and regularly scheduled principal payments on debt was 1.15; and the covenant for the maximum Leverage Ratio, defined as the ratio of total debt (including letters of credit) less aggregate cash balances to adjusted EBITDA was 4.0. Adjusted EBITDA is defined as (i) the sum of net income, interest expense, provisions for taxes based on income, total depreciation expense, total amortization expense and other non-cash items reducing net income minus (ii) other non-cash items increasing net income. Additionally, the Credit Facility limited capital expenditures to $28 million in 2002 and restricts the payment of cash dividends to common stockholders. As of September 28, 2002, the Company was in compliance with all covenants.

At September 28, 2002, the Company had $143 million of unused borrowing capacity under short and long-term lines of credit, including $128 million from the Credit Facility. Total debt decreased to $316 million at September 28, 2002 from $373 million at September 29, 2001. The reduction in debt primarily resulted from the application of $39 million from the November